Frontier markets struggle for air

26 Aug 2015

In a region in perpetual turmoil, capital markets have been hit hard. But there are some bright spots In late May, index provider the FTSE Group informed one of the MENA region's less renowned markets that it is on course for a possible upgrade to frontier market status during the next classification review this September.

The Palestine Exchange (PEX) was informed by the FTSE that it now meets the five markets criteria covering regulatory environment, capital controls, clearing and settlement, and market transparency.

Its chief executive, Ahmed Aweidah, says the upgrade is a signal to the international investment community of the level of good governance and quality infrastructure that PEX has built over the past few years, hoping that it will attract further foreign investment into the market.

With 49 listed firms, but a market capitalisation of only just over $3 billion, the Ramallah-based PEX is one of the MENA region's smaller markets, but one that has worked harder than most to attract investors and encourage local firms to list. It has opened the market to foreign investors without restrictions, making it the most open in the Arab world. It has also improved settlement times from T+3 to T+2 and enacted full delivery-versus-payment.

But the PEX, like other markets, has had a difficult year given the troubled political situation. Despite solid fundamentals, and strong dividend yields, Palestine's stock exchange has struggled to shrug off a deeply pessimistic political atmosphere in the occupied territories. In the first half of this year its index declined by 6.5 per cent, with only Iraq doing worse among MENA states.

That has not blunted Aweidah's efforts to get the PEX placed on other frontier market indices, such as the MSCI Frontier Market index. But to succeed, it will need greater liquidity.

The Palestinian Authority has abandoned plans to impose a dividend tax, which will give a boost to investor sentiment. It has also started to list bonds. Last year it listed one issued by Palestine Commercial Bank, and was planning for two initial public offerings (IPOs) in 2015, including one by a company that is building a new power plant in the north of the West Bank.

"That should be a $200 million company and is something to look forward to, particularly as the market performance of the other power company has been good and has been paying average dividend of 10 per cent a year for the last six to seven years," says Aweidah.

The Palestinian bourse's difficult year is one that has been shared by many others in the region. Of the non-GCC Arab markets, Tunisia is the best performing, showing an index rise of 12.4 per cent in the first half of 2015. Lebanon's Beirut Stock Exchange ( BSE ) is the only non-GCC Arab market index to end up in positive territory. The others - from Amman's 2.3 per cent decline to Egypt's 6.3 per cent fall, and the sharper 12.08 per cent drop seen in Iraq, have reflected the region's moribund equity market performances over the past year.

Arab stock markets increased by 1.5 per cent overall in the first half of 2015, while GCC markets rose by 3.6 per cent over the same period.

Lebanon's stock market remains shackled by a weak local economy, one that has been badly impacted by Syria's brutal conflict. The BSE remains small (with just 12 stocks) and like others, largely illiquid, and despite a sizeable increase in trading volumes in 2014 by 88.3 per cent to 96.8 million, its market cap at $11.5 billion, is largely made up of banking stocks.

The first half of this year has been better, though. BSE figures indicate that total trading volume reached 44.8 million shares in the first half of 2015, an increase of 50 per cent on the same period in 2014, while aggregate turnover amounted to $350.3 million, up by 54.1 per cent from a turnover of $227.4 million in the first half of 2014. Average daily trading in the first half was $2.9 million, which is again up by about half year-on-year. Large amounts of new equity has been issued by banks in the past year, as they seek to diversify their operations. That trend should persist through 2015.

The Beirut regulatory authorities have sought to modernise the local market, for example by establishing the Capital Markets Authority (CMA), which has focused on increasing trading activity on the bourse, encouraging the listing of new stocks.

But, warns one head of research at a large Beirut-based bank, it should be remembered that the BSE 's improvement this year is from an extremely low base to begin with. "We have not seen any new listings on the stock market that would make a trend, and liquidity is still tight and volumes are still low. The stock market is simply not relevant to financing economic activity, particularly when there are only 12 firms listed in total," he says.

Neighbouring Syria has still got a functioning stock exchange, despite the desperate situation there. The Damascus Securities Exchange (DSE) is operating at very subdued levels, with trade on the stock exchange valued at only $18 million during 2014, and a market capitalisation of about $700 million - of which 80 per cent is accounted for by banks, according to a new Chatham House study on the Syrian economy. The DSE index has shown a 5.6 per cent decline in the first half of 2015. Most funding for Syrian companies is coming from private banks, which have attracted a large slice of local foreign currency deposits.

Syria's neighbour Jordan has experienced tough economic conditions, given the negative impact that the regional turmoil has had on the financial market. The Amman Stock Exchange (ASE) is developing a strategic plan for the 2016-2018 period that will focus on modernising the market according to international standards, increasing competitiveness, enhancing investors' confidence in the market, and raising public awareness. The ASE is also preparing to implement a new version of the trading system (UTP-Hybrid) developed by NYSE Euronext, and new disclosure and surveillance systems. The ASE itself is keen to be transformed into a public shareholding company totally owned by the government as a first step, before going for an IPO.

Foreign investors, particularly from the Gulf, continue to show a strong interest in Jordan. The total value of shares that were bought by non-Jordanian investors in the first six months of 2015 was JD268.8 million ($379 million), representing 20.5 per cent of the overall trading value. Non-Jordanians' ownership in companies listed on the ASE by the end of June 2015 represented 49.1 per cent of the total market value, 36.3 per cent of this coming from Arab investors.

Iraq's sharp fall in the first half of this year underscores the specific challenges confronting the Iraq Stock Exchange (ISX). The war footing caused by the advance of the Islamic State (IS), together with lower oil prices, has had a big impact on the market. According to the Institute of International Finance, the rise of IS across large areas of Iraqi territory has dealt a serious blow to the country's ability to unite under a cohesive and credible central authority, even in a weaker, federated version. The economic fallout is already reflected in the contraction in non-oil output as security conditions deteriorate.

This has had a follow-through effect on the Iraq market. Foreign investors have sold down their positions, with sell-offs reaching more than 80 per cent of turnover in some of the large market caps. Prices plummeted and listed company earnings have been down substantially.

The banking sector has been particularly badly affected, with earnings declining at a rate of more than 20 per cent.

"There's been an exodus of foreigners from the stock market, and there hasn't been any significant inward investments to compensate," says an investment manager at an Iraq-focused fund management firm. This year has still seen some improvement in the ISX, with an 83 per cent increase in market capitalisation year-to-date at the end of June 2015, at $14.7 billion (though that figure is inflated by the listing of Zain Iraq, the country's biggest mobile phone operator by subscribers, in May of this year).

In Iraqi Kurdistan, the planned Erbil Stock Exchange has yet to get up and running, despite appointing a chief executive earlier this year. The Kurdish economy remains hamstrung by low oil prices and budget constraints imposed by Baghdad.

However, there is one significant prospect of improvement: the Iran nuclear agreement struck in mid-July, which heralds the Islamic republic's long-term re-emergence into the global financial community. That should benefit both the wider Iraqi economy, which is closely linked to its neighbour, as well as its Kurdish enclave.

"While a strong Iran is traditionally never good for Kurdistan, a less threatened Iran also means more stability for the region, so it's a trade-off," says Shwan Zulal, head of Cardouchi Consulting. "Companies here can use Kurdistan as a base for investing in Iran."

That is one of the best prospects for investors in emerging markets - though it begs the question, why not invest in the Islamic republic itself? Already, some are positioning to do just that.

Central Asian hedge fund firm Sturgeon Capital is reportedly planning to launch a hedge fund focused on Iran. The MENA region's frontier markets will have a fight on their hands if Iran's renaissance is cemented - though they too might ultimately stand to benefit from an improvement in the regional risk climate.